We spoke with Bernadine Geary, Director, Cashflow Finance at Fundamental Business Finance, who provided some insights to the...
Why The Loan Stacking “Rabbit Hole” Is Hurting Your Business
6 quick questions to ask yourself before venturing "Down the rabbit hole"Team Waddle
Once you’ve secured your first business loan, depending on your growth cycle, is it worth taking on another loan? i.e. “Loan Stacking”
Do you need to evaluate the real commercial benefit from taking on further funds with additional costs?
We had a conversation with a Waddle client recently that wanted to take our invoice financing solution and an unsecured business loan at the same time. When quizzed as to why he needed both, his answer was “I would like to have the funds in my account in case I need them”. What? Clearly, this does not make sense; you’re willing to cut into your profits with a fixed term loan simply because you like the idea of having the funds on account. Waddle offered a pay-as-you-go arrangement, meaning he would only pay for funds, as he needed them. With the fixed term loan, the full amount is borrowed from day one and repayments need to be made daily, weekly or monthly by direct deposit.
Obviously the above example doesn’t apply to all businesses. However, it should make you think why and how you will use loan facilities and ensuring you’re putting in place the correct ones that match your situation or opportunities.
We’ve listed a few questions you should ask yourself before deciding whether or not you should load your loan facilities.
How will I use the money?
How you use the money needs to be carefully thought out, are you investing it in stock, paying wages or catching up on tax debts? Or maybe if you just had a few more employees you’d be able to scale your business to take on new business.
On the downside, would you use the loan to pay creditors or solve an operational loss? If it feels like you need a cash injection for life support, then you may want to rethink taking out a second loan at this time as it could potentially place you in a worse position.
How’s growth going?
Is your business growing rapidly? Does it feel that you’re constantly fulfilling orders, keeping payments up to date and increasing your customer base? Then you may be a candidate for a traditional business loan.
On the other hand, if you are struggling financially and already have one loan, then careful consideration needs to be given before taking a new loan if it’s not to generate new revenue to make repayments and generate new profits which directly affects your ability to repay.
Does your first loan have favourable terms?
Do you know if your first loan facility would work alongside a second loan? If it’s a bank loan, will the bank release security (sometimes partial release can be obtained) or allow other lenders to finance them?
If the interest rates are low, the payments are comfortable, and you haven’t already used all of your assets as collateral, then chances are you may get the bank to release some security to allow you to borrow from another source.
That said, if you’ve already leveraged your assets or are paying a high amount of interest, then conditions may not be so favorable for an additional bank loan or another lender to consider giving you that additional loan as your servicing ratios may not suit a lot of loans in the market. That said there are other asset classes such as receivables that lenders will provide working capital against.
Should you take that second loan?
If your business is showing growth and you know that adding capital now will result in increased revenue gains, then it might be time to load your loans.
If, on the other hand, you need cash to fix a serious problem or dig yourself out of a hole, then stacking loans may not be your best bet.
It’s a pretty safe bet that if you get offered an attractive unsecured loan without the lender taking the time to consider affordability then take careful consideration as the cost and repayment terms might just sting you down the track. Remember that [inlinetweet prefix=”” tweeter=”” suffix=”@getwaddle”]the path of least resistance can sometimes be the path to hidden costs[/inlinetweet].
What will lenders think about loan stacking?
In short, the more loans you take, the worse your business will look. Most lenders consider it reasonable to have a few sources of traditional working capital plus equipment loans. What doesn’t look right are borrowers that have two (yes multiple identical lenders have thrown themselves at you) of the same unsecured loans, bank overdraft, and invoice factoring in place for obvious reasons it could indicate times of financial stress. This will also be added to loan servicing by banks and can eventually hurt your chances of securing healthy working capital.
Other sources of capital
There are other funding options out there aside from a loan. Don’t discount anything from financing invoices to taking on investors to outside-the-box methods of fundraising such as crowd funding. You can also seek angels investors and given improved conditions once the business is back on it’s feet, you’ll be in a position to apply for a low rate loan again from a bank or alternative lending source.
The Rabbit Hole
Where we see business owners making mistakes is venturing into the unknown with loans. Taking loans without fully understanding the pricing or terms is just one gotcha. Understanding how taking multiple loans can affect your ability to service, repay or obtain healthier terms in the future is the second gotcha. Thirdly, how this appears on your credit file is paramount when seeking healthy capital. Lenders can sometimes make assumption that you are simply borrowing from one lender to pay another which is a very unhealthy activity, one that usually ends up with undesirable outcomes as the pressure starts to mount from eroding profits and expensive interest charges.
Had any experience borrowing from two sources? A common one is an overdraft and an invoice financing facility together.